How To Use The P/E Ratio And PEG To Tell A Stock's Future

It is common practice for investors to use the price-to-earnings ratio (P/E ratio or price multiple) to determine if a company's stock price is over or undervalued. Companies with a high P/E ratio are typically growth stocks. However, their relatively high multiples do not necessarily mean their stocks are overpriced and not good buys for the long term.

TUTORIAL: Understanding the P/E Ratio

Let's take a closer look at what the P/E ratio tells us:

P/E Ratio

There are two primary components here, the market value (price) of the stock and the earnings of the company. Earnings are very important to consider. After all, earnings represent profits, and that's what every business strives for. Earnings are calculated by taking the hard figures into account: revenue, cost of goods sold (COGS), salaries, rent, etc. These are all important to the livelihood of a company. If the company isn't using its resources effectively it will not have positive earnings, and problems will eventually arise. Learn more about how to use the price-to-earnings ratio to reveal a stocks real market value. Read Profit With The Power Of Price-To-Earnings.)

Besides earnings, there are other factors that affect the value of a stock. For example:

•Brand - The name of a product or company has value. Established brands such as Proctor & Gamble are worth billions.

•Human Capital - Now more than ever, a company's employees and their expertise are thought to add value to the company.

•Expectations - The stock market is forward looking. You buy a stock because of high expectations for strong profits, not because of past achievements.

•Barriers to Entry - For a company to be successful in the long run, it must have strategies to keep competitors from entering the industry. For example, most anyone can make a soda, but marketing and distributing that beverage on the same level as Coca-Cola is very costly.

All these factors will affect a company's earnings growth rate. Because the P/E ratio uses past earnings (trailing 12 months), it gives a less accurate reflection of these growth potentials.

The relationship between the price/earnings ratio and earnings growth tells a more complete story than the P/E on its own. This is called the PEG ratio and is formulated as:

*The number used for annual growth rate can vary. It can be forward (predicted growth) or trailing, and either a one- to five-year time span. Check with the source providing the PEG ratio to see what kind of number they use.

Looking at the value of PEG of companies is similar to looking at the P/E ratio: A lower PEG means the stock is more undervalued.

Comparative Value

Let's demonstrate the PEG ratio with an example. Say you are interested in buying stock in one of two companies. The first is a networking company with 20% annual growth in net income and a P/E ratio of 50. The second company is in the beer brewing business. It has lower earnings growth at 10% and its P/E ratio is also relatively low at 15. (There are many other common ratios to use when comparing stocks, such as the P/S ratio. Learn more in How To Use Price-To-Sales Ratios To Value Stock.)

Many investors justify the stock valuations of tech companies by relying on the assumption that these companies have enormous growth potential. Can we do the same in our example?

Sponsored - Networking Company:

•P/E ratio (50) divided by the annual earnings growth rate (20) = PEG ratio of 2.5

Beer Company:

•P/E ratio (15) divided by the annual earnings growth rate (10) = PEG ratio of 1.5

The PEG ratio shows us that, when compare to the beer company, the always-popular tech company doesn't have the growth rate to justify its higher P/E, and its stock price appears overvalued.

The Bottom Line

Subjecting the traditional P/E ratio to the impact of future earnings growth produces the more informative PEG ratio. The PEG ratio provides more insight about a stock's current valuation. By providing a forward-looking perspective, the PEG is a valuable evaluative tool for investors attempting to discern a stock's future prospects.

(Every investor wants an edge in predicting a company's future, but a company's earnings guidance statements may not be a reliable source. To learn more, read Can Earnings Guidance Predict The Future ?)

Source: http://www.investopedia.com/
Disclaimer…The subject matters expressed above is based purely on technical analysis and personal opinions of the writer. it is not a solicitation to buy or sell.

Using Technical Indicators To Develop Trading Strategies

Indicators, such as moving averages and Bollinger Bands®, are mathematically-based technical analysis tools that traders and investors use to analyze the past and predict future price trends and patterns. Where fundamentalists may track economic reports and annual reports, technical traders rely on indicators to help interpret the market. The goal in using indicators is to identify trading opportunities. For example, a moving average crossover often predicts a trend change. In this instance, applying the moving average indicator to a price chart allows traders to identify areas where the trend may change. Figure 1 shows an example of a price chart with a 20-period moving average.

TUTORIAL: Economic Indicators

Figure 1: QQQQ with a 20-period moving average.

Source: Chart created with TradeStation.

Strategies, on the other hand, frequently employ indicators in an objective manner to determine entry, exit and/or trade management rules. A strategy is a definitive set of rules that specifies the exact conditions under which trades will be established, managed and closed. Strategies typically include the detailed use of indicators or, more frequently, multiple indicators, to establish instances where trading activity will occur. (Dig deeper into moving averages. Read Simple Vs. Exponential Moving Averages.)

While this article does not focus on any specific trading strategies, it serves as an explanation of how indicators and strategies are different, and how they work together to help technical analysts pinpoint high-probability trading setups. (For more, check out Create Your Own Trading Strategies.)

Indicators

A growing number of technical indicators are available for traders to study, including those in the public domain, such as a moving average or stochastic oscillator, as well as commercially available proprietary indicators. In addition, many traders develop their own unique indicators, sometimes with the assistance of a qualified programmer. Most indicators have user-defined variables that allow traders to adapt key inputs such as the “look back period” (how much historical data will be used to form the calculations) to suit their needs.

A moving average, for example, is simply an average of a security's price over a particular period. The time period is specified in the type of moving average; for instance, a 50-day moving average. This moving average will average the prior 50 days of price activity, usually using the security's closing price in its calculation (though other price points, such as the open, high or low can be used). The user defines the length of the moving average as well as the price point that will be used in the calculation. (To learn more, see our Moving Averages Tutorial.)

Strategies

A strategy is a set of objective, absolute rules defining when a trader will take action. Typically, strategies include both trade filters and triggers, both of which are often based on indicators. Trade filters identify the setup conditions; trade triggers identify exactly when a particular action should be taken. A trade filter, for example, might be a price that has closed above its 200-day moving average. This sets the stage for the trade trigger, which is the actual condition that prompts the trader to act – AKA, the line in the sand. A trade trigger might be when price reaches one tick above the bar that breached the 200-day moving average. Figure 2 shows a strategy utilizing a 20-period moving average with confirmation from the RSI. Trade entries and exits are illustrated with small black arrows.

Figure 2: This chart of QQQQ shows trades generated by a strategy based on a 20-period moving average. A ‘buy’ signal occurs at the open of the next bar after price has closed above the moving average. The strategy uses a profit target for the exit.

Source: Chart created with TradeStation.

To be clear, a strategy is not simply "Buy when price moves above the moving average." This is too evasive and does not provide any definitive details for taking action. Here are examples of some questions that need to be answered to create an objective strategy:

•What type of moving average will be used, including length and price point to be used in the calculation?

•How far above the moving average does price need to move?

•Should the trade be entered as soon as price moves a specified distance above the moving average, at the close of the bar, or at the open of the next bar?

•What type of order will be used to place the trade? Limit? Market?

•How many contracts or shares will be traded?

•What are the money management rules?

•What are the exit rules?

All of these questions must be answered to develop a concise set of rules to form a strategy.

Using Technical Indicators to Develop Strategies

An indicator is not a trading strategy. An indicator can help traders identify market conditions; a strategy is a trader's rulebook: How the indicators are interpreted and applied in order to make educated guesses about future market activity. There are many different categories of technical trading tools, including trend, volume, volatility and momentum indicators. Often, traders will use multiple indicators to form a strategy, though different types of indicators are recommended when using more than one. Using three different indicators of the same type - momentum, for example - results in the multiple counting of the same information, a statistical term referred to as multicollinearity. Multicollinearity should be avoided since it produces redundant results and can make other variables appear less important. Instead, traders should select indicators from different categories, such as one momentum indicator and one trend indicator. Frequently, one of the indicators is used for confirmation; that is, to confirm that another indicator is producing an accurate signal. (To learn more, see Regression Basics For Business Analysis.)

A moving average strategy, for example, might employ the use of a momentum indicator for confirmation that the trading signal is valid. One momentum indicator is the Relative Strength Index (RSI) which compares the average price change of advancing periods with the average price change of declining periods. Like other technical indicators, the RSI has user-defined variable inputs, including determining what levels will represent overbought and oversold conditions. The RSI, therefore, can be used to confirm any signals that the moving average produces. Opposing signals might indicate that the signal is less reliable and that the trade should be avoided.

Each indicator and indicator combination requires research to determine the most suitable application with respect to the trader's style and risk tolerance. One advantage to quantifying trading rules into a strategy is that it allows traders to apply the strategy to historical data to evaluate how the strategy would have performed in the past, a process known as backtesting. Of course, this does not guarantee future results, but it can certainly help in the development of a profitable trading strategy. (Learn more about the benefits and drawbacks of backtesting. Read Backtesting And Forward Testing: The Importance Of Correlation.)

Regardless of which indicators are used, a strategy must identify exactly how the indicators will be interpreted and precisely what action will be taken. Indicators are tools that traders use to develop strategies; they do not create trading signals on their own. Any ambiguity can lead to trouble.

Choosing Indicators to Develop a Strategy

What type of indicator a trader uses to develop a strategy depends on what type of strategy he or she intends on building. This relates to trading style and risk tolerance. A trader who seeks long-term moves with large profits might focus on a trend-following strategy, and, therefore, utilize a trend-following indicator such as a moving average. A trader interested in small moves with frequent small gains might be more interested in a strategy based on volatility. Again, different types of indicators may be used for confirmation. Figure 2 shows the four basic categories of technical indicators with examples of each.

Figure 3: The four basic categories of technical indicators.

Traders do have the option to purchase "black box" trading systems, which are commercially available proprietary strategies. An advantage to purchasing these black box systems is that all of the research and backtesting has theoretically been done for the trader; the disadvantage is that the user is "flying blind" since the methodology is not usually disclosed, and often the user is unable to make any customizations to reflect his or her trading style. (Learn how black-box systems work with intelligent ETFs in Sharpen Your Portfolio With Intelligent ETFs.)

Conclusion

Indicators alone do not make trading signals. Each trader must define the exact method in which the indicators will be used to signal trading opportunities and to develop strategies. Indicators can certainly be used without being incorporated into a strategy; however, technical trading strategies usually include at least one type of indicator. Identifying an absolute set of rules, as with a strategy, allows traders to backtest to determine the viability of a particular strategy. It also helps traders understand the mathematical expectancy of the rules, or how the strategy should perform in the future. This is critical to technical traders since it helps traders continually evaluate the performance of the strategy and can help determine if and when it is time to close a position.

Traders often talk about the Holy Grail - the one trading secret that will lead to instant profitability. Unfortunately, there is no perfect strategy that will guarantee success for each investor. Each trader has a unique style, temperament, risk tolerance and personality. As such, it is up to each trader to learn about the variety of technical analysis tools that are available, research how they perform according to their individual needs and develop strategies based on the results. (For more, check out Survive The Trading Game.)

Source ; http://www.investopedia.com

Definition of 'Bollinger Band®

A band plotted two standard deviations away from a simple moving average, developed by famous technical trader John Bollinger.

In this example of Bollinger Bands®, the price of the stock is banded by an upper and lower band along with a 21-day simple moving average.

Investopedia explains 'Bollinger Band®'

Because standard deviation is a measure of volatility, Bollinger Bands® adjust themselves to the market conditions. When the markets become more volatile, the bands widen (move further away from the average), and during less volatile periods, the bands contract (move closer to the average). The tightening of the bands is often used by technical traders as an early indication that the volatility is about to increase sharply.

This is one of the most popular technical analysis techniques. The closer the prices move to the upper band, the more overbought the market, and the closer the prices move to the lower band, the more oversold the market.

Source : http://www.investopedia.com

Disclaimer…The subject matters expressed above is based purely on technical analysis and personal opinions of the writer. it is not a solicitation to buy or sell.

Trading The MACD Divergence

Moving average convergence divergence (MACD), invented in 1979 by Gerald Appeal, is one of the most popular technical indicators in trading. The MACD is appreciated by traders the world over for its simplicity and flexibility because it can be used either as a trend or momentum indicator.

See also: Technical Analysis Works In Forex Markets.

Trading divergence is a popular way to use the MACD histogram (which we explain below), but, unfortunately, the divergence trade is not very accurate - it fails more than it succeeds. To explore what may be a more logical method of trading the MACD divergence, we look at using the MACD histogram for both trade entry and trade exit signals (instead of only entry), and how currency traders are uniquely positioned to take advantage of such a strategy. (To learn more, see The Greatest Currency Trades Ever Made and Technical Analysis.)

MACD: An Overview

The concept behind the MACD is fairly straightforward. Essentially, it calculates the difference between an instrument's 26-day and 12-day exponential moving averages (EMA). Of the two moving averages that make up the MACD, the 12-day EMA is obviously the faster one, while the 26-day is slower. In the calculation of their values, both moving averages use the closing prices of whatever period is measured. On the MACD chart, a nine-day EMA of the MACD itself is plotted as well, and it acts as a trigger for buy and sell decisions. The MACD generates a bullish signal when it moves above its own nine-day EMA, and it sends a sell sign when it moves below its nine-day EMA.

The MACD histogram is an elegant visual representation of the difference between the MACD and its nine-day EMA. The histogram is positive when the MACD is above its nine-day EMA and negative when the MACD is below its nine-day EMA. If prices are rising, the histogram grows larger as the speed of the price movement accelerates, and contracts as price movement decelerates. The same principle works in reverse as prices are falling. See Figure 1 for a good example of a MACD histogram in action.

Figure 1: MACD histogram. As price action (top part of the screen) accelerates to the downside, the MACD histogram (in the lower part of the screen) makes new lows

Source: FXTrek Intellicharts

The MACD histogram is the main reason why so many traders rely on this indicator to measure momentum, because it responds to the speed of price movement. Indeed, most traders use the MACD indicator more frequently to gauge the strength of the price move than to determine the direction of a trend. (To learn more, see Momentum Trading With Discipline.)

Trading Divergence

As we mentioned earlier, trading divergence is a classic way in which the MACD histogram is used. One of the most common setups is to find chart points at which price makes a new swing high or a new swing low, but the MACD histogram does not, indicating a divergence between price and momentum. Figure 2 illustrates a typical divergence trade.

Figure 2: A typical (negative) divergence trade using a MACD histogram. At the right-hand circle on the price chart, the price movements make a new swing high, but at the corresponding circled point on the MACD histogram, the MACD histogram is unable to exceed its previous high of 0.3307. (The histogram reached this high at the point indicated by the lower left-hand circle.) The divergence is a signal that the price is about to reverse at the new high, and as such, it is a signal for the trader to enter into a short position.

Source: FXTrek Intellicharts

Unfortunately, the divergence trade is not very accurate, as it fails more times than it succeeds. Prices frequently have several final bursts up or down that trigger stops and force traders out of position just before the move actually makes a sustained turn and the trade becomes profitable. Figure 3 demonstrates a typical divergence fakeout, which has frustrated scores of traders over the years. (To learn more, see Using Double Tops And Double Bottoms In Currency Trading.)

Try Currency Trading Risk-Free at FOREX.com

Figure 3: A typical divergence fakeout. Strong divergence is illustrated by the right circle (at the bottom of the chart) by the vertical line, but traders who set their stops at swing highs would have been taken out of the trade before it turned in their direction.

Source: Source: FXTrek Intellicharts

One of the reasons that traders often lose with this set up is they enter a trade on a signal from the MACD indicator but exit it based on the move in price. Since the MACD histogram is a derivative of price and is not price itself, this approach is, in effect, the trading version of mixing apples and oranges.

Using the MACD Histogram for Both Entry and Exit

To resolve the inconsistency between entry and exit, a trader can use the MACD histogram for both trade entry and trade exit signals. To do so, the trader trading the negative divergence takes a partial short position at the initial point of divergence, but instead of setting the stop at the nearest swing high based on price, he or she instead stops out the trade only if the high of the MACD histogram exceeds its previous swing high, indicating that momentum is actually accelerating and the trader is truly wrong on the trade. If, on the other hand, the MACD histogram does not generate a new swing high, the trader then adds to his or her initial position, continually achieving a higher average price for the short.

Currency traders are uniquely positioned to take advantage of this strategy because with this strategy, the larger the position, the larger the potential gains once the price reverses - and in Forex (FX), you can implement this strategy with any size of position and not have to worry about influencing price. (Traders can execute transactions as large as 100,000 units or as little as 1,000 units for the same typical spread of three to five points in the major pairs.)

In effect, this strategy requires the trader to average up as prices temporarily move against him or her. This, however, is typically not considered a good strategy. Many trading books have derisively dubbed such a technique as "adding to your losers." However, in this case the trader has a logical reason for doing so - the MACD histogram has shown divergence, which indicates that momentum is waning and price may soon turn. In effect, the trader is trying to call the bluff between the seeming strength of immediate price action and the MACD readings that hint at weakness ahead. Still, a well-prepared trader using the advantages of fixed costs in FX, by properly averaging up the trade, can withstand the temporary drawdowns until price turns in his or her favor. Figure 4 illustrates this strategy in action.

Figure 4: The chart indicates where price makes successive highs but the MACD histogram does not - foreshadowing the decline that eventually comes. By averaging up his or her short, the trader eventually earns a handsome profit as we see the price making a sustained reversal after the final point of divergence.

Source: Source: FXTrek Intellicharts

The Bottom Line

Like life, trading is rarely black and white. Some rules that traders agree on blindly, such as never adding to a loser, can be successfully broken to achieve extraordinary profits. However, a logical, methodical approach for violating these important money management rules needs to be established before attempting to capture gains. In the case of the MACD histogram, trading the indicator instead of the price offers a new way to trade an old idea - divergence. Applying this method to the FX market, which allows effortless scaling up of positions, makes this idea even more intriguing to day traders and position traders alike.

Source: http://www.investopedia.com/
Disclaimer…The subject matters expressed above is based purely on technical analysis and personal opinions of the writer. it is not a solicitation to buy or sell.

What Investors Should Know About Interest Rates

If you're ever looking for a topic to kill conversation so that you can be left alone to think about your investments, start talking about interest rates. Your listener's eyes are guaranteed to glaze over, and you'll be alone in no time.

But if you own investments, the topic is not as dry as you think. In fact, it is something investors should make an effort to understand. According to financial theory, interest rates - which change all the time - are fundamental to company valuation, and therefore play an important role in how we put a price on stocks. Here we take a look at the relationship between interest rates and stock price. (For background reading, check out How Interest Rates Affect The Stock Market.)

Tutorial: Fundamental Analysis

Interest Rates: The Cost of Money

Think of an interest rate as the cost of money, which - just like the cost of production, labor, and other expenses - is a factor of a company's profitability.

The fundamental cost of money to an investor is the Treasury note rate, whose return is guaranteed by the "full faith and credit" of the U.S. government. According to financial theory, a stock's value proposition starts there: stocks are risky assets, even riskier than bonds because bondholders are paid their capital before stockholders in the event of bankruptcy. Therefore, investors require a higher return for taking on extra risk by investing in stocks instead of Treasury notes, which are guaranteed to pay a certain return.

The extra return that investors can theoretically expect from stocks is referred to as the "risk premium". Historically, the risk premium runs at around 7%. This means that if the risk-free rate (the Treasury note rate) is 4%, then investors would demand a return of 11% from a stock. Therefore, the total return on a stock is the sum of two parts: the risk-free rate and the risk premium. If you want higher returns, you must invest in riskier stocks because they offer a higher risk premium than, say, stronger blue chip companies. In theory, rational investors will select an investment with a return that is high enough to compensate for the lost opportunity of earning interest from the guaranteed Treasury note and for taking on additional risk. (To learn more, see The Equity-Risk Premium: More Risk For Higher Returns.)

Risk and Return: An Inverse Relationship

If the required return rises, the stock price will fall, and vice versa. This makes sense: if nothing else changes, the price needs to be lower for the investor to have the required return. There is an inverse relationship between required return and the stock price investors assign to a stock.

The required return might rise if the risk premium or the risk-free rate increases. For instance, the risk premium might go up for a company if one of its top managers resigns or if the company suddenly decides to lower its dividend payments. And the risk-free rate will increase if interest rates rise.

So, changes in interest rates impact the theoretical value of companies and their shares: basically, a share's fair value is its projected future cash flows discounted to the present using the investor's required rate of return. If interest rates fall and everything else is held constant, share value should rise. That's why the market cheers when the U.S. Federal Reserve announces a rate cut. Conversely, if the Fed raises rates (holding everything else constant), share values ought to fall.

How Interest Rates Affect Companies

Interest rates impact a company's operations too. Any increase in the interest rates that it pays will raise its cost of capital. Therefore, a company has to work harder to generate higher returns in a high interest environment. Otherwise, the bloated interest expense will eat away at its profits. Lower profits, lower cash inflows and a higher required rate of return for investors all translate into depressed fair value for the company's stock.

Sponsored - Free Currency Trading eBook From Forex.com

Moreover, if interest rate costs shoot up to such a level that the company has problems paying off its debt, then its survival may be threatened. In that case, investors will demand an even higher risk premium. As a result, the fair value will fall even further. (Find out what debt can do to your investment in Will Corporate Debt Drag Your Stock Down?)

Finally, high interest rates normally go hand in hand with a sluggish economy. They prevent people from buying things and companies from investing in growth opportunities. As a result, sales and profits drop, and so do share prices.

Conclusion

In financial theory, valuation begins with a simple question: if you put money into this company, what are the chances you will get a better return than if you invest in something else? Interest rates play an important part in determining what that something else might be.

Source: http://www.investopedia.com/

Disclaimer…The subject matters expressed above is based purely on technical analysis and personal opinions of the writer. it is not a solicitation to buy or sell.

Why China's Currency Tangos With The USD

China's economic rise in the modern world began with a reformist leader in the early 1980s named Deng Xiaoping. By introducing policies that opened China to trade and economic relations with the outside world, Xiaoping led China on a quasi-capitalist venture that would continue for 30 years.

One of the ways China's economic rise was accomplished was to by pegging its currency, the Chinese yuan (also known as the renminbi) to the U.S. dollar and instituting trading arrangements between the two nations. China's trade with the United States began in 1985 with imports to the U.S. totaling almost $4 million, according to the U.S. Census Bureau. This number has grown each year since that time. In 2008, imports from China totaled $337.8 billion.

How Pegging a Currency Affects an Economy

From 1985 to 2008, U.S. exports to China have been equivalent to about one-third of China's exports to the U.S.. So the Chinese peg to the dollar has been quite beneficial for China's exporting businesses. In addition, pegging the yuan to the dollar made investors much more confident in China's currency. Without the peg, China's economic rise would have been much slower because the yuan was nearly worthless compared to all leading economic nations of the world. (Take a look at the controversy around cheap imports in Do Cheap Imported Goods Cost Americans Jobs?)

In particular, the Chinese accomplished its fast economic rise by pegging its yuan to the dollar at a very low rate. China does not price its currency based on interest rates because interest rates are not a monetary tool used by the Chinese, unlike other leading nations. Instead, China prices its currency based on Chinese banks' reserve requirements. Rather than appreciating or depreciating the yuan based on an interest rate, or allowing the yuan to float freely on the open market, the Chinese hold their currency price steady based on a fixed exchange rate regime. Increasing reserve requirements serves to reduce the amount of currency in the economy and decreasing requirements increases the amount of money available for use. (Learn about fixed and floating exchange rates in Currency Exchange: Floating Rate Vs. Fixed Rate.)

The Yuan/Dollar Relationship

One of the arguments against a yuan/dollar relationship is that it appears that China benefits more than the United States. Manufacturers in the U.S. often put pressure on Congress to lobby China to appreciate its currency, citing the difficulty of competing against artificially cheap Chinese goods as a reason for change. Year after year, new bills are introduced by Congress demanding that China appreciate its currency so the yuan/dollar balance is more equalized. They claim the Chinese are protecting their trade superiority and the U.S. is forced to pay the price.

The problem from China's perspective is that appreciating the yuan could mean less foreign investment in China, deflation, lower wages and unemployment in the country. Fewer exports will also diminish China's supply of dollars for investment, both inside and outside the country. China argues that the currency peg is meant to foster economic stability and abandoning the peg could result in an economic crisis.

When Undervalued Is a Good Thing

Some benefits of an undervalued yuan for the U.S. include lower prices for consumers, lower inflationary pressure and lower input prices for U.S. manufactures that use Chinese inputs. Alternatively, an undervalued yuan hurts U.S. industries that compete with cheap Chinese goods, thus hurting production and employment in the U.S. Also, a low yuan makes U.S. exports more expensive to Chinese consumers and reduces exports to China.

As of 2009, the yuan/dollar mid-point was pegged at 6.8339. This means that one U.S. dollar = 6.8339 Chinese yuan. As with any commodity, if the demand for yuan increases or decreases, the central bank has to respond accordingly by supplying or removing currency from the markets to restore equilibrium and maintain the peg. The Chinese central bank will buy or sell either dollars or yuan to maintain the desired balance.

Usually, central banks will buy or sell their own currency to maintain the peg, as it's U.S. dollars the Chinese wish to accumulate through balance of trade with the United States. Appreciating the yuan means the Chinese would accumulate less in foreign reserve dollars and disrupt the economic stability they have grown accustomed to since they began trading with the United States and the outside world. (For more insight, see What Is The Balance Of Payments?)

The Bottom Line

China finds itself in a unique situation. Calls for China to appreciate its currency places the country in a no-win situation with trading partners due to fear of inflation at home and the possibility of earning less in foreign reserves. Yet the yuan/dollar peg must be maintained for both sides due to the abundance of trade each side maintains. (For additional reading, take a look at Global Trade and The Currency Market.)

Source: www.investopedia.com/

Disclaimer…The subject matters expressed above is based purely on technical analysis and personal opinions of the writer. it is not a solicitation to buy or sell.

How To Pump Up Your Portfolio With ETFs

Similar to mutual funds, exchange-traded funds (ETFs) allow access to a number of types of stocks and bonds (or asset classes), provide an efficient means to construct a fully diversified portfolio, include index- and more active-management strategies and are comprised of individual stocks or bonds. But ETFs also differ from mutual funds, and in ways that are advantageous to investors.
Unlike mutual funds, ETFs are traded like any stock or bond and offer liquidity throughout the day. Moreover, ETFs generally do not pay out dividends and capital gains - instead, distributions are rolled into the trading price, allowing investors to avoid a taxable event.

In this article, we'll show you how to add these funds to your portfolio to make it more liquid, user-friendly and profitable.

Tutorial: All About Exchange-Traded Funds (ETFs)

Portfolio Construction

Modern portfolio construction theory (MPT) is centered on the concept that asset classes behave differently from one another. This means each asset class has its own unique risk and return profile, and reacts differently during various economic events and cycles. The idea of combining various asset classes, each with unique attributes, is the basis for building a diversified portfolio. ETFs provide small investors with a vehicle to achieve asset class diversification, substantially reducing overall portfolio risk. (To learn more about MPT, see Modern Portfolio Theory: An Overview.)

Risk reduction is a concept that means many things to many people; therefore, a brief discussion of its use, in this context, is warranted.

Reducing Risk

Many investors believe that by holding a portfolio of 30 or more U.S. large-cap stocks, they are achieving sufficient diversification. This is true in that they are diversifying against company-specific risk, but such a portfolio is not diversified against the systematic behavior of U.S. large-cap stocks.

For example, U.S. large-cap stocks' monthly returns, as a whole, averaged in the high teens, as seen in the S&P 500's 15% average return between 1997 to 2007. So, this means that if you held just U.S. large-cap stocks, you should reasonably expect to see volatility in your portfolio of plus or minus 15% on any given month. Such a high degree of volatility could be unsettling and drive irrational behavior, such as selling out of fear or buying and leveraging out of greed. As such, risk reduction, in this context, would involve the minimization of monthly fluctuations in portfolio value.

Many ETF Asset Classes

There are many equity asset class exposures available through ETFs. These include international large-cap stocks, U.S. mid- and small-cap stocks, emerging market stocks and sector ETFs. Although some of these asset classes are more volatile than U.S. large caps, traditionally, they can be combined to minimize portfolio volatility with a high degree of certainty. Simply put, this is because they generally "zig" and "zag" in different directions at different times. However, in times of extreme market stress, all equity markets tend to behave poorly over the short term. Because of this, investors should consider adding fixed-income exposure to their portfolios.

ETFs also offer exposure to U.S. nominal and inflation-protected fixed income. Unlike equities, fixed-income asset classes generally offer mid-single-digit levels of volatility, making them ideal tools to reduce total portfolio risk. However, investors must be careful to neither use too little or too much fixed income given their investment horizons. You can even purchase ETFs that track commodities such as gold or silver or funds that gain when the overall market falls.

An individual's investment horizon generally depends on the number of years until that person's retirement. So, recent college graduates have about a 40-year time horizon (long-term), middle-aged people about a 20-year time horizon (mid-term) and those nearing or at retirement have a time horizon of zero-10 years (short-term). Considering that equity investments can easily underperform bonds over periods as long as 10 years and that bear markets can last many years, investors must have a healthy fear of market volatility and budget their risk appropriately. (Read more about time horizons in Seven Common Investor Mistakes and The Seasons Of An Investor's Life.)

Let's look at an example:

Example - Investment Horizon and Risk

It could be appropriate for a recent college graduate to adopt a 100% equity allocation. Conversely, it could be inappropriate for someone five years away from retirement to adopt such an aggressive posture. Nonetheless, it is not uncommon to see individuals with insufficient retirement assets bet on equity market appreciation to overcome savings shortfalls. This is the greedy side of investor behavior, which could rapidly turn to fear in the face of a bear market, leading to disastrous results. Keep in mind that saving appropriately is just as important as how you structure your investments. (Find out who shouldn't be involved in 100% equity allocation in The All-Equities Portfolio Fallacy.)

ETF Advantages in Portfolio Construction

In the context of portfolio construction, ETFs (especially index ETFs) offer many advantages over mutual funds. First and foremost, index ETFs are very cheap relative to any actively managed retail mutual fund. Such funds will typically charge about 1 to 1.5%, whereas index ETFs charge fees around 0.25 to 0.50%. Consider the benefits of saving 1% in fees on a $1-million portfolio - $10,000 per annum. Fee savings add up over time, and should not be discounted during your portfolio design process.

Additionally, index ETFs sidestep another potential pitfall for individual investors: the risk that actively managed retail funds will fail to succeed. Generally speaking, individual investors are often ill-equipped to evaluate the prospective success of an actively managed fund. This is due to a lack of analytical tools, access to portfolio managers and an overall lack of a sophisticated understanding of investments. Studies have shown that active managers generally fail to beat relevant market indexes over time. As such, picking a successful manager is difficult for even trained investment professionals.

Individual investors should therefore avoid active managers and the need to continuously watch, analyze and evaluate success or failure. Moreover, because the majority of your portfolio's return will be determined by asset class exposures, there are little benefit to this pursuit. Avoiding active managers through index ETFs is yet another way to diversify and reduce portfolio risk. (To find out more about management, read Words From The Wise On Active Management.)

Conclusion

Index ETFs can be a valuable tool to individual investors in constructing a fully diversified portfolio. They offer cheap access to systematic risk exposures, such as the various U.S. and international equity asset classes as well fixed-income investments. They are traded daily like stocks, and can be purchased cheaply through your favorite discount brokerage firm. Index ETFs also avoid the risks of active management and the headaches of monitoring and evaluating those types of products. All in all, index ETFs offer unsophisticated investors the opportunity to build a relatively sophisticated portfolio with few headaches and at substantial cost savings. Consider them seriously in your investment activities.

Source : http://www.investopedia.com/

Disclaimer…The subject matters expressed above is based purely on technical analysis and personal opinions of the writer. it is not a solicitation to buy or sell.

How To Interpret Technical Analysis Price Patterns: Triple Tops And Bottoms

Price patterns are identifiable sequences of price bars that appear in technical analysis charts. These patterns can be used by technical analysts to examine past price movements and predict future ones for a particular trading instrument. Readers should already be familiar with trendlines, continuation price patterns and reversal price patterns. (If you aren't, check out Introduction To Technical Analysis Price Patterns.) In this article, we will explore how to interpret the patterns once they have been identified, and examine the rare but powerful triple tops and bottoms patterns.
TUTORIAL: Trader's Guide To Technical Analysis

Duration
The duration of the price pattern is an important consideration when interpreting a pattern and forecasting future price movement. Price patterns can appear on any charting period, from a fast 144-tick chart, to 60-minute, daily, weekly or annual charts. The significance of a pattern, however, is often directly related to its size and depth.

Patterns that emerge over a longer period of time generally are more reliable, with larger moves resulting once price breaks out of the pattern. Therefore, a pattern that develops on a daily chart is expected to result in a larger move than the same pattern observed on an intraday chart, such as a one-minute chart. Likewise, a pattern that forms on a monthly chart is likely to lead to a more substantial price move than the same pattern on a daily chart.

Price patterns appear when investors or traders become used to buying and selling at certain levels, and therefore, price oscillates between these levels, creating patterns such as flags, pennants and the like. When price finally does break out of the price pattern, it can represent a significant change in sentiment. The longer the duration, the harder buyers will have to push to break above an area of resistance (and the harder sellers will have to push to break below an area of support), resulting in a more formidable move once price does break in either direction. Figure 1 shows a pennant price pattern that formed on the weekly chart of Google (NYSE:GOOG). Once price continued in its established direction, the upward move was substantial.

Figure 1: GOOG continues a significant uptrend following this well-formed pennant that formed on a weekly chart.

Source: Chart created with TradeStation 9.0.

Volatility
Similarly, the degree to which price fluctuates within a price pattern can be useful in analyzing the validity of a price pattern, as well as in predicting the magnitude of the eventual price breakout. Volatility is a measurement of the variation of prices over time. Greater price fluctuations indicate increased volatility, a condition that can be interpreted as a more active battle between the bears, who are trying to push prices down, and the bulls, who are trying to thrust prices up. Patterns exhibiting larger degrees of volatility are likely to result in more significant price moves once price breaks out of the pattern. (To learn how to calculate volatility, see A Simplified Approach To Calculating Volatility.)

Larger price movements within the pattern may signify that the opposing forces – the bulls and the bears – are engaged in a serious battle, rather than a mild scuffle. The greater the volatility within the price pattern, the more anticipation builds, leading to a more significant, possibly explosive, price move as price breaches the level of support or resistance.

Volume
Volume is another consideration when interpreting price patterns. Volume signifies the number of units of a particular trading instrument that have changed hands during a specified time period. Typically, a trading instrument’s volume is displayed as a histogram, or a series of vertical lines, appearing beneath the price chart. Volume is most useful when measured relative to its recent past. Changes in the amount of buying and selling that is occurring can be compared with recent activity and analyzed: any volume activity that diverges from the norm can suggest an upcoming change in price.

If price breaks above or below an area of resistance or support, respectively, and is accompanied by a sudden increase in investor and trader interest - represented in terms of volume - the resulting move is more likely to be significant. The increase in volume can confirm the validity of the price breakout. A breakout with no noticeable increase in volume, on the other hand, has a far greater chance of failing since there is no enthusiasm to back the move, particularly if the move is to the upside.

Guidelines for Interpreting Patterns

Three general steps help technical analysts interpret price patterns:

•Identify: The first step in successfully interpreting price patterns is to identify valid patterns in real time. The patterns are often easy to find on historical data, but can become more challenging to pick out while they are forming. Traders and investors can practice identifying patterns on historical data, paying close attention to the method that is used for drawing trendlines. Trendlines can be constructed using highs and lows, closing prices, or another data point in each price bar.

•Evaluate: Once a pattern is identified, it can be evaluated. Traders and investors can consider the duration of the pattern, accompanying volume and the volatility of the price swings within the price pattern. Evaluating these can give a better picture regarding the validity of the price pattern.

•Forecast: Once the pattern has been identified and evaluated, traders and investors can use the information to form a prediction, or to forecast future price movements. Naturally, price patterns do not always cooperate, and identifying one does not guarantee that any particular price action will occur. Market participants, however, can be on the lookout for activity that is likely to occur, enabling them to respond quickly to changing market conditions. (For related reading on forecasting, see Forecasting Market Direction With Put/Call Ratios.)

Triple Tops and Bottoms

Triple tops and bottoms are extensions of double tops and bottoms. If the double tops and bottoms resemble “M” and “W,” the triple tops and bottoms bear a resemblance to the cursive “M” or “W”: three pushes up (in a triple top) or three pushes down (for a triple bottom). These price patterns represent multiple failed attempts to break through an area of support or resistance. In a triple top, price makes three tries to break above an established area of resistance, fails and recedes. A triple bottom, in contrast, occurs when price makes three stabs at breaking through a support level, fails and bounces back up.

A triple top formation is a bearish pattern since the pattern interrupts an uptrend and results in a trend change to the downside. Its formation is as follows:

•Prices move higher and higher and eventually hit a level of resistance, falling back to an area of support.
•Price tries again to test the resistance levels, fails and returns towards the support level.
•Price tries once more, unsuccessfully, to break through resistance, falls back and through the support level.

This price action represents a duel between buyers and sellers; the buyers try to lift prices higher, while the sellers try to push prices lower. Each test of resistance is typically accompanied by decreasing volume, until price falls through the support level with increased participation and corresponding volume. When three attempts to break through an established level of resistance have failed, the buyers generally become exhausted, the sellers take over and price falls, resulting in a trend change.

Triple bottoms, on the other hand, are bullish in nature because the pattern interrupts a downtrend, and results in a trend change to the upside. The triple bottom price pattern is characterized by three unsuccessful attempts to push price through an area of support. Each successive attempt is typically accompanied by declining volume, until price finally makes its last attempt to push down, fails and returns to go through a resistance level. Like triple tops, this pattern is indicative of a struggle between buyers and sellers. In this case, it is the sellers who become exhausted, giving way to the buyers to reverse the prevailing trend and become victorious with an uptrend. Figure 2 shows a triple bottom that developed on a daily chart of McGraw Hill (NYSE:MHP).

Figure 2: A triple bottom forms on the daily McGraw Hill chart, leading to a trend reversal.

Source: Chart created with TradeStation 9.0.

A triple top or bottom signifies that an established trend is weakening, and that the other side is gaining strength. Both represent a shift in pressure: with a triple top, there is a shift from buyers to sellers; a triple bottom indicates a shift from sellers to buyers. These patterns provide a visual representation of the changing of the guard, so to speak, when power switches hands.

Bottom Line
Price patterns occur on any charting period, whether on fast tick charts used by scalpers or yearly charts used by investors. Each pattern represents a struggle between buyers and sellers, resulting in the continuation of a prevailing trend or the reversal of the trend, depending on the outcome. Technical analysts can use price patterns to help evaluate past and current market activity, and forecast future price action in order to make trading and investing decisions.

byJean Folger

Jean Folger is co-author of the award winning book Make Money Trading: How to Build a Winning Trading Business, and has written numerous articles appearing in Futures Magazine, Smart Trade Digest and other online venues. She is co-author of the eBooks Volatility Indicators: Techniques for Profiting from the Market's Moves; and High Profits in High Heels: Secrets from Today's Top Women Traders.

Jean is a system researcher for PowerZone Trading, LLC , a company she co-founded to develop commercial indicators and custom trading systems for the TradeStation and NinjaTrader platforms. Previously, Jean was a real estate broker and a high school English teacher. Jean can be reached at jean@powerzonetrading.com.


Source :  http://www.investopedia.com/

Disclaimer…The subject matters expressed above is based purely on technical analysis and personal opinions of the writer. it is not a solicitation to buy or sell.

4 Types Of Indicators FX Traders Must Know

Many forex traders spend their time looking for that perfect moment to enter the markets or a telltale sign that screams "buy" or "sell". And while the search can be fascinating, the result is always the same. The truth is, there is no one way to trade the forex markets. As a result, successful traders must learn that there are a variety of indicators that can help to determine the best time to buy or sell a forex cross rate.
Here are four different market indicators that most successful forex traders rely upon.

Indicator No.1: A Trend-Following Tool

It is possible to make money using a countertrend approach to trading. However, for most traders the easier approach is to recognize the direction of the major trend and attempt to profit by trading in the trend’s direction. This is where trend-following tools come into play. Many people misunderstand the purpose of trend-following tools and try to use them as separate trading systems. While this is possible, the real purpose of a trend-following tool is to suggest whether you should be looking to enter a long position or a short position. So let’s consider one of the simplest trend-following methods – the moving average crossover.

A simple moving average represents the average closing price over the number of days in question. To elaborate, let’s look at two simple examples – one longer term, one shorter term. (For related information on moving averages, see Exploring The Exponentially Weighted Moving Average.)

Figure 1 displays the 50-day/200-day moving average crossover for the euro/yen cross. The theory here is that the trend is favorable when the 50-day moving average is above the 200-day average and unfavorable when the 50-day is below the 200-day. As the chart shows, this combination does a good job of identifying the major trend of the market - at least most of the time. However, no matter what moving average combination you choose to use, there will be whipsaws.

Figure 1: The euro/yen with 50-day and 200-day moving averages

Source: ProfitSource

Figure 2 shows a different combination – the 10-day/30-day crossover. The advantage of this combination is that it will react more quickly to changes in price trends than the previous pair. The disadvantage is that it will also be more susceptible to whipsaws than the longer term 50-day/200-day crossover.

Figure 2: The euro/yen with 10-day and 30-day moving averages

Source: ProfitSource

Many investors will proclaim a particular combination to be the best, but the reality is, there is no “best” moving average combination. In the end, forex traders will benefit most by deciding what combination (or combinations) fits best with their time frames. From there, the trend - as shown by these indicators - should be used to tell traders if they should trade long or trade short; it should not be relied on to time entries and exits. (For additional information, check out Forex: Should You Be Trading Trend Or Range?)

Indicator No.2: A Trend-Confirmation Tool

Now we have a trend-following tool to tell us whether the major trend of a given currency pair is up or down. But how reliable is that indicator? As mentioned earlier, trend-following tools are prone to being whipsawed. So it would be nice to have a way to gauge whether the current trend-following indicator is correct or not. For this, we will employ a trend-confirmation tool. Much like a trend-following tool, a trend-confirmation tool may or may not be intended to generate specific buy and sell signals. Instead, we are looking to see if the trend-following tool and the trend-confirmation tool agree.

In essence, if both the trend-following tool and the trend-confirmation tool are bullish, then a trader can more confidently consider taking a long trade in the currency pair in question. Likewise, if both are bearish, then the trader can focus on finding an opportunity to sell short the pair in question.

One of the most popular – and useful – trend confirmation tools is known as the moving average convergence divergence (MACD). This indicator first measures the difference between two exponentially smoothed moving averages. This difference is then smoothed and compared to a moving average of its own. When the current smoothed average is above its own moving average, then the histogram at the bottom of Figure 3 is positive and an uptrend is confirmed. On the flip side, when the current smoothed average is below its moving average, then the histogram at the bottom of Figure 3 is negative and a downtrend is confirmed. (Learn more about the MACD in A Primer On The MACD.)

Figure 3: Euro/yen cross with 50-day and 200-day moving averages and MACD indicator

Source: ProfitSource

In essence, when the trend-following moving average combination is bearish (short-term average below long-term average) and the MACD histogram is negative, then we have a confirmed downtrend. When both are positive, then we have a confirmed uptrend.

At the bottom of Figure 4 we see another trend-confirmation tool that might be considered in addition to (or in place of) MACD. It is the rate of change indicator (ROC). As displayed in Figure 4, the red line measures today’s closing price divided by the closing price 28 trading days ago. Readings above 1.00 indicate that the price is higher today than it was 28 days ago and vice versa. The blue line represents a 28-day moving average of the daily ROC readings. Here, if the red line is above the blue line, then the ROC is confirming an uptrend. If the red line is below the blue line, then we have a confirmed downtrend. (For more on the ROC indicator, refer to Measure Momentum Change With ROC.)

Note in Figure 4 that the sharp price declines experienced by the euro/yen cross from mid-January to mid-February, late April through May and during the second half of August were each accompanied by:


•The 50-day moving average below the 200-day moving average


•A negative MACD histogram


A bearish configuration for the ROC indicator (red line below blue)


Figure 4: Euro/yen cross with MACD and rate-of-change trend confirmation indicators

Source: ProfitSource.com


Indicator No.3: An Overbought/Oversold Tool

While traders are typically well advised to trade in the direction of the major trend, one must still decide whether he or she is more comfortable jumping in as soon as a clear trend is established or after a pullback occurs. In other words, if the trend is determined to be bullish, the choice becomes whether to buy into strength or buy into weakness. If you decide to get in as quickly as possible, you can consider entering a trade as soon as an uptrend or downtrend is confirmed. On the other hand, you could wait for a pullback within the larger overall primary trend in the hope that this offers a lower risk opportunity. For this, a trader will rely on an overbought/oversold indicator. There are many indicators that can fit this bill. However, one that is useful from a trading standpoint is the three-day relative strength index, or three-day RSI for short. This indicator calculates the cumulative sum of up days and down days over the window period and calculates a value that can range from zero to 100. If all of the price action is to the upside, the indicator will approach 100; if all of the price action is to the downside, then the indicator will approach zero. A reading of 50 is considered neutral. (More on the RSI can be found in Relative Strength Index Helps Make The Right Decisions.)

Figure 5 displays the three-day RSI for the euro/yen cross. Generally speaking, a trader looking to enter on pullbacks would consider going long if the 50-day moving average is above the 200-day and the three-day RSI drops below a certain trigger level, such as 20, which would indicate an oversold position. Conversely, the trader might consider entering a short position if the 50-day is below the 200-day and the three-day RSI rises above a certain level, such as 80, which would indicate an overbought position. Different traders may prefer using different trigger levels.

Figure 5: Euro/yen cross with three-day RSI overbought/oversold indicator

Source: ProfitSource

Indicator No.4: A Profit-Taking Tool

The last type of indicator that a forex trader needs is something to help determine when to take a profit on a winning trade. Here too, there are many choices available. In fact, the three-day RSI can also fit into this category. In other words, a trader holding a long position might consider taking some profits if the three-day RSI rises to a high level of 80 or more. Conversely, a trader holding a short position might consider taking some profit if the three-day RSI declines to a low level, such as 20 or less.

Another useful profit-taking tool is a popular indicator known as Bollinger bands. This tool adds and subtracts the standard deviation of price data changes over a period from the average closing price over that same time frame to create trading “bands”. While many traders attempt to use Bollinger bands to time the entry of trades, they may be even more useful as a profit-taking tool.

Figure 6 displays the euro/yen cross with 20-day Bollinger Bands overlaying the daily price data. A trader holding a long position might consider taking some profits if the price reaches the upper band, and a trader holding a short position might consider taking some profits if the price reaches the lower band. (Refer to The Basics Of Bollinger Bands for more information on this tool.)

Figure 6: Euro/Yen cross with Bollinger bands

Source: ProfitSource

A final profit-taking tool would be a “trailing stop.” Trailing stops are typically used as a method to give a trade the potential to let profits run, while also attempting to avoid losing any accumulated profit. There are many ways to arrive at a trailing stop. Figure 7 illustrates just one of these ways.

The trade shown in Figure 7 assumes that a short trade was entered in the forex market for the euro/yen on January 1, 2010. Each day the average true range over the past three trading days is multiplied by five and used to calculate a trailing stop price that can only move sideways or lower (for a short trade, or sideways or higher for a long trade).

Figure 7: Euro/yen cross with a trailing stop

The Bottom Line

If you are hesitant to get into the forex market and are waiting for an obvious entry point, you may find yourself sitting on the sidelines for a long while. By learning a variety of forex indicators, you can determine suitable strategies for choosing profitable times to back a given currency pair. Also, continued monitoring of these indicators will give strong signals that can point you toward a buy or sell signal. As with any investment, strong analysis will minimize potential risks.

by Jay Kaeppel

Jay Kaeppel is a trading strategist with Optionetics, Inc. and writes a weekly column, Kaeppel's Corner for optionetics.com. Kaeppel has been active in financial markets for over two decades. He was the head trader at a CTA for 8 years and a trading system and trading software developer for 15 years. As an author, Kaeppel has published three books on trading, "The Four Biggest Mistakes in Option Trading" (1998), "The Four Biggest Mistakes in Futures Trading"(2000), "The Option Trader's Guide to Probability, Volatility and Timing"(2002) and "Seasonal Stock Market Trends: The Definitive Guide to Seasonal Stock Market Trading"(2009). He has written over 25 articles for magazines, such as Stocks and Commidities and Active Trader.

Source : http://www.investopedia.com/

Disclaimer…The subject matters expressed above is based purely on technical analysis and personal opinions of the writer. it is not a solicitation to buy or sell.

9 Tricks Of The Successful Forex Trader

For all of its numbers, charts and ratios, trading is more art than science. Just as in artistic endeavors, there is talent involved, but talent will only take you so far. The best traders hone their skills through practice and discipline. They perform self analysis to see what drives their trades and learn how to keep fear and greed out of the equation. In this article we'll look at nine steps a novice trader can use to perfect his or her craft; for the experts out there, you might just find some tips that will help you make smarter, more profitable trades, too.

TUTORIAL: Beginner's Guide To MetaTrader 4

Step 1. Define your goals and then choose a style of trading that is compatible with those goals. Be sure your personality is a match for the style of trading you choose.

Before you set out on any journey, it is imperative that you have some idea of where your destination is and how you will get there. Consequently, it is imperative that you have clear goals in mind as to what you would like to achieve; you then have to be sure that your trading method is capable of achieving these goals. Each type of trading style requires a different approach and each style has a different risk profile, which requires a different attitude and approach to trade successfully. For example, if you cannot stomach going to sleep with an open position in the market then you might consider day trading. On the other hand, if you have funds that you think will benefit from the appreciation of a trade over a period of some months, then a position trader is what you want to consider becoming. But no matter what style of trading you choose, be sure that your personality fits the style of trading you undertake. A personality mismatch will lead to stress and certain losses. (For more, see Invest With A Thesis.)

Step 2. Choose a broker with whom you feel comfortable but also one who offers a trading platform that is appropriate for your style of trading.

It is important to choose a broker who offers a trading platform that will allow you to do the analysis you require. Choosing a reputable broker is of paramount importance and spending time researching the differences between brokers will be very helpful. You must know each broker's policies and how he or she goes about making a market. For example, trading in the over-the-counter market or spot market is different from trading the exchange-driven markets. In choosing a broker, it is important to read the broker documentation. Know your broker's policies. Also make sure that your broker's trading platform is suitable for the analysis you want to do. For example, if you like to trade off of Fibonacci numbers, be sure the broker's platform can draw Fibonacci lines. A good broker with a poor platform, or a good platform with a poor broker, can be a problem. Make sure you get the best of both. (For related reading, see How To Pay Your Forex Broker.)

Step 3. Choose a methodology and then be consistent in its application.

Before you enter any market as a trader, you need to have some idea of how you will make decisions to execute your trades. You must know what information you will need in order to make the appropriate decision about whether to enter or exit a trade. Some people choose to look at the underlying fundamentals of the company or economy, and then use a chart to determine the best time to execute the trade. Others use technical analysis; as a result they will only use charts to time a trade. Remember that fundamentals drive the trend in the long term, whereas chart patterns may offer trading opportunities in the short term. Whichever methodology you choose, remember to be consistent. And be sure your methodology is adaptive. Your system should keep up with the changing dynamics of a market. (For related reading, see What is the difference between fundamental and technical analysis and Blending Technical And Fundamental Analysis.)

Step 4. Choose a longer time frame for direction analysis and a shorter time frame to time entry or exit.

Many traders get confused because of conflicting information that occurs when looking at charts in different time frames. What shows up as a buying opportunity on a weekly chart could, in fact, show up as a sell signal on an intraday chart. Therefore, if you are taking your basic trading direction from a weekly chart and using a daily chart to time entry, be sure to synchronize the two. In other words, if the weekly chart is giving you a buy signal, wait until the daily chart also confirms a buy signal. Keep your timing in sync.

Step 5. Calculate your expectancy.

Expectancy is the formula you use to determine how reliable your system is. You should go back in time and measure all your trades that were winners versus all your trades that were losers. Then determine how profitable your winning trades were versus how much your losing trades lost.

Take a look at your last 10 trades. If you haven't made actual trades yet, go back on your chart to where your system would have indicated that you should enter and exit a trade. Determine if you would have made a profit or a loss. Write these results down. Total all your winning trades and divide the answer by the number of winning trades you made. Here is the formula:

E= [1+ (W/L)] x P – 1

where:

W = Average Winning Trade

L = Average Losing Trade

P = Percentage Win Ratio

Example:

If you made 10 trades and six of them were winning trades and four were losing trades, your percentage win ratio would be 6/10 or 60%. If your six trades made $2,400, then your average win would be $2,400/6 = $400. If your losses were $1,200, then your average loss would be $1,200/4 = $300. Apply these results to the formula and you get; E= [1+ (400/300)] x 0.6 - 1 = 0.40 or 40%. A positive 40% expectancy means that your system will return you 40 cents per dollar over the long term.

Step 6. Focus on your trades and learn to love small losses.

Once you have funded your account, the most important thing to remember is that your money is at risk. Therefore, your money should not be needed for living or to pay bills etc. Consider your trading money as if it were vacation money. Once the vacation is over your money is spent. Have the same attitude toward trading. This will psychologically prepare you to accept small losses, which is key to managing your risk. By focusing on your trades and accepting small losses rather than constantly counting your equity, you will be much more successful.

Get Trend Analysis

Secondly, only leverage your trades to a maximum risk of 2% of your total funds. In other words, if you have $10,000 in your trading account, never let any trade lose more than 2% of the account value, or $200. If your stops are farther away than 2% of your account, trade shorter time frames or decrease the leverage. (For further reading, see Leverage's Double-Edged Sword Need Not Cut Deep.)

Step 7. Build positive feedback loops.

A positive feedback loop is created as a result of a well-executed trade in accordance with your plan. When you plan a trade and then execute it well, you form a positive feedback pattern. Success breeds success, which in turn breeds confidence - especially if the trade is profitable. Even if you take a small loss but do so in accordance with a planned trade, then you will be building a positive feedback loop.

Step 8. Perform weekend analysis.

It is always good to prepare in advance. On the weekend, when the markets are closed, study weekly charts to look for patterns or news that could affect your trade. Perhaps a pattern is making a double top and the pundits and the news are suggesting a market reversal. This is a kind of reflexivity where the pattern could be prompting the pundits while the pundits are reinforcing the pattern. Or the pundits may be telling you that the market is about to explode. Perhaps these are pundits hoping to lure you into the market so that they can sell their positions on increased liquidity. These are the kinds of actions to look for to help you formulate your upcoming trading week. In the cool light of objectivity, you will make your best plans. Wait for your setups and learn to be patient. (For information on determining what the market's telling you, read Listen To The Market, Not Its Pundits.)

If the market does not reach your point of entry, learn to sit on your hands. You might have to wait for the opportunity longer than you anticipated. If you miss a trade, remember that there will always be another. If you have patience and discipline you can become a good trader. (To learn more, see Patience Is A Trader's Virtue.)

Step 9. Keep a printed record.

Keeping a printed record is one of the best learning tools a trader can have. Print out a chart and list all the reasons for the trade, including the fundamentals that sway your decisions. Mark the chart with your entry and your exit points. Make any relevant comments on the chart. File this record so you can refer to it over and over again. Note the emotional reasons for taking action. Did you panic? Were you too greedy? Were you full of anxiety? Note all these feelings on your record. It is only when you can objectify your trades that you will develop the mental control and discipline to execute according to your system instead of your habits.

Bottom Line

The steps above will lead you to a structured approach to trading and in return should help you become a more refined trader. Trading is an art and the only way to become increasingly proficient is through consistent and disciplined practice. Remember the expression: the harder you practice the luckier you'll get.

by Selwyn Gishen


Selwyn Gishen is a trader with more than 15 years of experience trading forex and equities for a private equity fund. For the past 35 years, he has also been a student of metaphysics, and has written a book called "Mind: How Changing Your Mind Can Change Your Life!" (2007). Gishen is the founder of FXNewsandViews.Com and the author of a forex trading guide entitled "Trading the Forex Markets: A Foundation Course for Online Traders". The course is designed to provide the trader with all the aspects of Gishen's Fusion Trading Model.

Disclaimer…The subject matters expressed above is based purely on technical analysis and personal opinions of the writer. it is not a solicitation to buy or sell.

Currency Exchange: Floating Rate Vs. Fixed Rate

Did you know that the foreign exchange market (also known as FX or forex) is the largest market in the world? In fact, more than $3 trillion is traded in the currency markets on a daily basis, as of 2009. This article is certainly not a primer for currency trading, but it will help you understand exchange rates and fluctuation.

What Is an Exchange Rate?
An exchange rate is the rate at which one currency can be exchanged for another. In other words, it is the value of another country's currency compared to that of your own. If you are traveling to another country, you need to "buy" the local currency. Just like the price of any asset, the exchange rate is the price at which you can buy that currency. If you are traveling to Egypt, for example, and the exchange rate for U.S. dollars is 1:5.5 Egyptian pounds, this means that for every U.S. dollar, you can buy five and a half Egyptian pounds. Theoretically, identical assets should sell at the same price in different countries, because the exchange rate must maintain the inherent value of one currency against the other.

Fixed Exchange Rates
There are two ways the price of a currency can be determined against another. A fixed, or pegged, rate is a rate the government (central bank) sets and maintains as the official exchange rate. A set price will be determined against a major world currency (usually the U.S. dollar, but also other major currencies such as the euro, the yen or a basket of currencies). In order to maintain the local exchange rate, the central bank buys and sells its own currency on the foreign exchange market in return for the currency to which it is pegged.

SEE: What Are Central Banks? and Get To Know The Major Central Banks

If, for example, it is determined that the value of a single unit of local currency is equal to US$3, the central bank will have to ensure that it can supply the market with those dollars. In order to maintain the rate, the central bank must keep a high level of foreign reserves. This is a reserved amount of foreign currency held by the central bank that it can use to release (or absorb) extra funds into (or out of) the market. This ensures an appropriate money supply, appropriate fluctuations in the market (inflation/deflation) and ultimately, the exchange rate. The central bank can also adjust the official exchange rate when necessary.

Floating Exchange Rates
Unlike the fixed rate, a floating exchange rate is determined by the private market through supply and demand. A floating rate is often termed "self-correcting," as any differences in supply and demand will automatically be corrected in the market. Look at this simplified model: if demand for a currency is low, its value will decrease, thus making imported goods more expensive and stimulating demand for local goods and services. This in turn will generate more jobs, causing an auto-correction in the market. A floating exchange rate is constantly changing.

In reality, no currency is wholly fixed or floating. In a fixed regime, market pressures can also influence changes in the exchange rate. Sometimes, when a local currency reflects its true value against its pegged currency, a "black market” (which is more reflective of actual supply and demand) may develop. A central bank will often then be forced to revalue or devalue the official rate so that the rate is in line with the unofficial one, thereby halting the activity of the black market.

In a floating regime, the central bank may also intervene when it is necessary to ensure stability and to avoid inflation. However, it is less often that the central bank of a floating regime will interfere.

The World Once Pegged
Between 1870 and 1914, there was a global fixed exchange rate. Currencies were linked to gold, meaning that the value of a local currency was fixed at a set exchange rate to gold ounces. This was known as the gold standard. This allowed for unrestricted capital mobility as well as global stability in currencies and trade. However, with the start of World War I, the gold standard was abandoned.

SEE: The Gold Standard Revisited

At the end of World War II, the conference at Bretton Woods, an effort to generate global economic stability and increase global trade, established the basic rules and regulations governing international exchange. As such, an international monetary system, embodied in the International Monetary Fund (IMF), was established to promote foreign trade and to maintain the monetary stability of countries and therefore, that of the global economy.

SEE: What Is The International Monetary Fund?

It was agreed that currencies would once again be fixed, or pegged, but this time to the U.S. dollar, which in turn was pegged to gold at US$35 per ounce. What this meant, was that the value of a currency was directly linked with the value of the U.S. dollar. So, if you needed to buy Japanese yen, the value of the yen would be expressed in U.S. dollars, whose value in turn was determined in the value of gold. If a country needed to readjust the value of its currency, it could approach the IMF to adjust the pegged value of its currency. The peg was maintained until 1971, when the U.S. dollar could no longer hold the value of the pegged rate of US$35 per ounce of gold.

From then on, major governments adopted a floating system, and all attempts to move back to a global peg were eventually abandoned in 1985. Since then, no major economies have gone back to a peg, and the use of gold as a peg has been completely abandoned.

Why Peg?
The reasons to peg a currency are linked to stability. Especially in today's developing nations, a country may decide to peg its currency to create a stable atmosphere for foreign investment. With a peg, the investor will always know what his or her investment's value is, and therefore will not have to worry about daily fluctuations. A pegged currency can also help to lower inflation rates and generate demand, which results from greater confidence in the stability of the currency.

Fixed regimes, however, can often lead to severe financial crises, since a peg is difficult to maintain in the long run. This was seen in the Mexican (1995), Asian (1997) and Russian (1997) financial crises: an attempt to maintain a high value of the local currency to the peg resulted in the currencies eventually becoming overvalued. This meant that the governments could no longer meet the demands to convert the local currency into the foreign currency at the pegged rate. With speculation and panic, investors scrambled to get their money out and convert it into foreign currency before the local currency was devalued against the peg; foreign reserve supplies eventually became depleted. In Mexico's case, the government was forced to devalue the peso by 30%. In Thailand, the government eventually had to allow the currency to float, and by the end of 1997, the Thai bhat had lost 50% of its value as the market's demand and supply readjusted the value of the local currency.

SEE: What Causes A Currency Crisis?

Countries with pegs are often associated with having unsophisticated capital markets and weak regulating institutions. The peg is there to help create stability in such an environment. It takes a stronger system as well as a mature market to maintain a float. When a country is forced to devalue its currency, it is also required to proceed with some form of economic reform, like implementing greater transparency, in an effort to strengthen its financial institutions.

Some governments may choose to have a "floating," or "crawling" peg, whereby the government reassesses the value of the peg periodically and then changes the peg rate accordingly. Usually, this causes devaluation, but it is controlled to avoid market panic. This method is often used in the transition from a peg to a floating regime, and it allows the government to "save face" by not being forced to devalue in an uncontrollable crisis.

The Bottom Line
Although the peg has worked in creating global trade and monetary stability, it was used only at a time when all the major economies were a part of it. While a floating regime is not without its flaws, it has proven to be a more efficient means of determining the long-term value of a currency and creating equilibrium in the international market.

by Reem Heakal

Source :http://www.investopedia.com/
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